Introduction

Multiple theorists have attempted to explain the three major changes in corporate form between the late 19th and late 20th century- from the holding company, to the multidivisional form (MDF), to the multilayer subsidiary form (MLSF). However, political theory, institutional theory, and economic theory all have competing explanations which comes along with different strengths and weaknesses.

Historical Changes in Dominant Corporate Form

Political theory, institutional theory and economic theory each address the change from a holding company to the multidivisional form (MDF) to the multi-layered subsidiary form (MLSF). Before attempting to address each theory’s explanation of this change, we must first explain the differences between each of the organizational forms, and explain their historical context.

The Holding Company

​The holding company operates as a financial management company. It does not produce commodities itself. Instead it owns controlling stock of multiple relatively-autonomous, legally-distinct production companies.

The rise of the holding company is the result of a split between the ownership and control of organizations (Berle and Means 1932). In the United States, the first corporations emerged in the 1800s, mainly for public goods. It was traditionally a private organization, held by a small set of owners who control the organization. However, in order to internally develop funds, companies would sell their stock to the public. The dispersion of ownership is inherent in the modern corporation (Berle and Means 1932). As the size of the corporation increases, ownership becomes more diffused. The dispersion of ownership has facilitated the dominance of the holding company, especially after the Civil War.

The holding company came to rise in post Civil War during the antebellum period, especially in regards to the growth of railroad corporations (Berle and Means 1932). During this period of time, the holding company attempted to vertically integrate and ownership became increasingly centralized and concentrated. This lead to the rise of the large corporation and the establishment of monopolies (Berle and Means 1932). Although ownership became centralized through strategies of vertical integration, the holding company had problems with control (Fligstein 1985). The holding company facilitated a house of cards such that, once problems with control came to fuition and the holding company became bankrupt, the whole economy failed. This ended up leading to the Great Depression and the state’s response: the New Deal (Prechel 2000). The New Deal broke up the holding company.

The Multidivisional Form

​The Celler-Kefauver Amendment was enacted in 1950 because people were weary of the increasing size of organizations and their influence on the market due to the Great Depression. The Celler-Kefauver Amendment limited vertical integration, forcing organizations to diversify in order to grow. Furthermore, in response to problems with the holding company, corporations developed a structure which would provide both flexibility and control. As such, the MDF was developed. In short, the MDF rose along with the diversification of product lines (Fligstein 1985).

The MDF consists of a single company who has a central headquarters and and multiple relatively-autonomous departments for different product lines or regions. Whereas in the holding company, those with decision making authority are within a legally separate organization, those with decision making power in the MDF are located within the company at central headquarters.

The Multilayered-Subsidiary Form

​Neo-liberalism came to rise in the late 1970s and early 1980s. Neo-liberalism is an ideology that promotes the free market claiming corporations should not be restrained in pursuing their self interest. This ideology led to the Tax Reform Act of 1986 which eliminated tax transfers within subsidiaries of a holding company. This has wide spread implications because it eliminated the tax and reporting of transfers within subsidiaries, which eliminated the costs associated with the subsidiary structure (Prechel 1997). Furthermore, it provided companies with an opportunity to internally raise capital (Prechel 2000). The MLSF’s ability to internally raise capital became a vital incentive throughout the 1970s. As such, the MLSF has become and continues to be the dominant corporate form in the United States.

The MLSF is similar to the holding company. However, the MLSF has the organizational capacity to financially manage the subsidiaries whereas the holding company’s subsidiaries functioned more autonomously. Additionally, the MLSF structure is much more complex than the holding company.Whereas the holding company consisted of two layers: the holding company and its productive subsidiaries, the MLSF can consist of numerous layers and subsidiaries can operate as holding companies. This change has facilitated financial malfeasance, as it creates a liability firewall between parent companies and subsidiaries (Prechel and Morris 2010).

Economic Theory Explanations of Changes in Corporate Structure

Economic theory assumes decisions in organizations are made by rational actors in an attempt to increase efficiency. Furthermore, they assume profits represent efficiency (Perrow 1986). According to economic theorists, organizations are the embodiment of value-based contracts. Contracts are the mechanisms for transactions. Organizations are established to reduce the transaction costs of organized social activity (Coase 1937). In short, according to economic theory, corporate structure is organized in such a way to minimize transaction costs.

From the perspective of economic theory, changes in corporate form from the holding company to the MDF to the MLSF is the result of actions motivated by efficiency. Certain corporate structures fit best with particular corporate strategies (Chandler 1962). According to Chandler (1962), the rise of the MDF is the result of a shift in corporate strategy. Corporate strategy shifted away from vertical integration and towards diversification. The holding company was a better fit for vertical integration strategies, as it centralized control of the entire production process (something beneficial when pursuing vertical integration). On the other hand, MDF is a better fit for diversification strategies, as it decentralized control and increases the adaptability and flexibility of the company (something beneficial when pursuing diversification). Change in corporate form is the result of changes in corporate strategy, which requires a new structure to be efficient.

Although economic theory provides an explanation of changes in corporate structure, it is inadequate. Economic theorists assume the behavior of individuals is rational and purely related to economic interests. As such, economic theorists tend to ignore the complexities of organizations and overlook motives for the behavior of individuals in organization, such as professional norms and political power (Perrow 1986). Furthermore, empirical research does not support economic theory claims that changes in corporate structure are related to efficiency and productivity (Roy 1997).

Political ​Theory Explanations of Changes in Corporate Structure

Whereas economic theory ignores political power, political theory focuses on it. Political theory challenges economic theory assumptions that corporate behavior is due to efficiency. From the political theory perspective, individual decisions are more related to power than efficiency. Organizational behavior is explained as a result of powerful coalitions aiming to reduce uncertainty by interacting with their environment (Pfeffer and Salancik 1978).

According to economic theory, organizations change as a result of conflict over resources and changing power relations. Corporate change is the result of corporate attempts to overcome constraints to capital accumulation (Prechel 1994). In an attempt to ensure its survival, organizations will behave in ways to reduce their uncertainty, whether this be through (1) political lobbying of the state, or (2) placing individuals with perceived capacities to better deal face critical uncertainties into leadership positions. Changes in organizational form can be the result of either of this two responses to the uncertainty facing organizations due to resource dependence.

In conflict over critical resources, corporations will lobby the state to change public policy to better suit their interests, facilitating changes in corporate form. For example, in the 1970s, due to globalization, corporations became financially constrained and faced difficulty raising capital (Prechel and Boies 1998). As such, corporations politically mobilized, leading to the passage of the Tax Reform Act of 1986, which eliminated the costs of the subsidiary structure created after the great depression. Changes in state structure initiated by corporate actors provided an opportunity for companies to change to the MLSF. Futhermore, the MLSF decreased corporate uncertainty and resource dependence by allowing corporations to internally raise capital, creating incentives for companies to adopt the MLSF (Prechel 1997). In an attempt to better accumulate capital, corporate actors worked together to pressure the state to change regulations, creating opportunities and incentives for corporate structure to change.

According to political theorists, change in corporate structure is also the result of power shifts. The characteristics of those who control the organizations tend to change over time, depending on who is conceived to best handle organizational uncertainties. As individuals rise in power, they act in ways to ensure their power is maintained. For example, when companies pursue diversification strategies, finance is viewed as a critical contingency and finance professionals are placed into positions of power (Zorn 2004). Upon gaining power, individuals with a background in finance use their position to structure the company in a way that allows growth through diversification, thus ensuring their power is maintained (Fligstein 1985). In short, according to political theory, changes in corporate structure are the result of power dynamics.

Political theory is a strong perspectivive explaining the political dimensions associated with organizational which has an ample amount of empirical support. For example, there is empirical evidence supporting political theory's claim that factors such as political action, capital dependence and financial risk are related to the adoption of the MLSF (Boies and Prechel 2002; Prechel and Boies 1998; Prechel, Boies and Woods 1999). However in an event-history model of MDF adoption, Palmer, Jennings and Zhou (1993) found little support for the straightforward political view (form prevalence and CEO prior sales experience was more related to change in corporate form than CEO financial expertise and ownership network), while finding significant support for institutional theory perspectives.

Institutional ​Theory Explanations of Changes in Corporate Structure

Institutional theories center around how the institutional environment impacts organizational behavior. From this perspective institutional isomorphism primarily determines corporate behavior. Institutional isomorphism is the process by which organizations tend to become similar to their institutional environment (DiMaggio and Powell 2007). Isomorphism can occur through three different processes: coercive, mimetic and normative isomorphism (DiMaggio and Powell 2007). Coercive isomorphism stems from political influence and the problem of legitimacy; they are forced to change due to cultural expectations of competitors, suppliers, consumers or the state. For example, changes in state regulation after the Great Depression forced corporations to eliminate structural monopolies. Mimetic isomorphism results from standard responses to uncertainty; they are pressured to mimic other prestigious organizations. For example, a company that is struggling may see how other more successful companies have a different structure and will attempt to replicate their success and adopt a new corporate form. Normative isomorphism is associated with professionalism; they tend to follow a professional world view. For example, business schools may emphasize the benefits of the MLSF, promoting companies to change their form to that which is idealized in business school. In short, according to institutional theory, change in corporate form is the result of institutional isomorphism.

Whereas political theory views corporations as political actors attempting to increase control of their environment, institutional theory conceptualizes corporations as institutional actors responding to environmental pressures. From this perspective, in an attempt to secure legitimacy from external actors, corporations do not attempt to change their institutional environment, instead, they conform to it. As such, it fails to explain corporate political actions to change state regulation, facilitating a change in corporate structure.

Systematic research also provides evidence in support for insitutitional theories. For example, Palmer, Jennings and Zhou (1993) found institutional factors, such as the prevalence of the MDF in the industry, CEO background at elite business schools, and directional and nondirectional ties to other MDF firms, explained corporate adoption of the MDF better than political and economic factors. However, institutional theory is limited as it does not adequately conceptualize organizations as powerful political actors. Institutionalism tends to focus on normative and mimetic pressures while ignoring coercion (Mizruchi and Fein 1999). Furthermore, it focuses on how organizations become increasingly similar and does not adequately explain differences among organizations. In conclusion, institutional theory views individuals and organizations as relatively passive and minimizes the importance of agency and heterogeneity.

Conclusion

As you can see, many theories attempt to explain the change of corporate form. Each theory also comes with its own set of strengths and weaknesses. According to economic theorists, corporate form changed in order to reduce transaction costs. Political theorists, on the other hand, claim that corporate form changed due to conflict over resources and the political actions of powerful corporate actors. Finally, institutional theorists claim change in organizational form is due to institutional isomorphism.

Pfeffer, Jeffrey and Gerald R. Salancik. 1978. The External Control of Organizations: A Resource Dependence Perspective. New York: Harper and Row.

Prechel, Harland. 1994. “Economic Crisis and the Centralization of Control over the Managerial Process: Corporate Restructuring and Neo-Fordist Decision Making.” American Sociological Review 59:723–745.

Prechel, Harland and Theresa Morris. 2010. “The Effects of Organizational and Political Embeddedness on Financial Malfeasance in the Largest U.S. Corporations: Dependence, Incentives and Opportunities.” American Sociological Review 75:331–354.

Roy, William. 1997. Socializing Capital: The Rise of the Large Industrial Corporation in America. Princeton, NJ: Princeton University Press.

Zorn, Dirk. 2004. “Here a Chief, There a Chief: The Rise of the CFO in the American Firm.” American Sociological Review 69:345–364.